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Dipen Chatterjee, B.A.LL.B The author is working as a principal legal associate of Global Absolute Capital Advisors Private limited, a boutique investment banking company based in Mumbai. He has previously worked for APJ-SLG law Offices as a corporate finance lawyer. The author represents that the information contained herein is not intended to be an offer to buy or sell, or a solicitation of an offer to buy or sell any securities, or as an official confirmation of any transaction. The information contained herein this document including any expression of opinion herein is from publicly available data or other sources believed to be reliable, but the author do not warrant or guarantee that it is accurate or complete and it should not be relied on as such, although the author believes it to be fair and not misleading or deceptive. The contents of this document should not be construed as a legal opinion or advice.
Electronic copy available at: http://ssrn.com/abstract=1328822
What are Foreign Currency Convertible Bonds? With inorganic options in the overseas markets and capital expansion plans in the domestic market beckoning, Indian corporations are putting their best foot forward when it comes to arranging finances. While there are a plethora of options available for the same today including ADR/GDR issues, qualified institutional placements, private equity placement, public issue and the plain vanilla bank funding, the option that seemed to have been the cynosure of India Inc was foreign currency convertible bond better known as FCCB. Foreign currency convertible bond (FCCB) is a convertible bond issued by a country in a currency different than the its own currency. This is the powerful instrument by which the country raises the money in the form of a foreign currency. The bond acts like both a debt and equity instrument. Like bonds it makes regular coupon and principal payments, but these bonds also give the bondholder the option to convert the bond into stock. The Ministry of Finance government of India defines FCCB. According to it, "Foreign Currency Convertible Bonds" means bonds issued in accordance with this scheme and subscribed by a non- resident in foreign currency and convertible into ordinary shares of the issuing company in any manner, either in whole, or in part, on the basis of any equity related warrants attached to debt instruments". The relatively attractive return on investments offered by emerging markets like India, increased international recognition of strong economic fundamentals of the Indian economy and demand for funds from Indian companies to finance the ambitious capex plans fuelled the spurt in FCCB issues over the last couple of years. It is also worth noting that while most of the issues carried zero coupon rates, conversion price of FCCBs issued by Indian companies were fairly attractive (at a considerable premium to the market price as on the date of issuance). And, being a hybrid instrument, the coupon rates on FCCBs were typically lower than pure debt or zero, thereby reducing the debt-financing costs. It saved the risk of immediate equity dilution as in the case of public issues. Investors get guaranteed returns on the bond in the form of coupon rates and opportunity to take advantage of the price appreciation in the stock, which would be activated when the price of the stock reaches a certain point. Not to mention the substantial yield-tomaturity (YTM), which is guaranteed at maturity. Despite the all the positives linked to the instrument, what gets ostensibly ignored are some of the risks that are attached to it. For example, FCCBs do not portray the real extent of leveraging and do not divulge the exact date of conversion, as there is a reasonable time period available for investors to exercise the option. Usually, the company’s ability to meet the repayment obligations if the issue does not get converted into equity - is not looked into. Also, the zero coupon FCCBs fail to factor in the cost of servicing the debt (the promised yield to maturity) in case of non-conversion. After a salubrious initial period for foreign currency convertible bonds (FCCBs) as a way of financing, Indian companies could now be facing some harsh reality. This is because, most of the bonds are up for redemption pretty soon and with the markets taking a beating, many calculations could go wrong, and this could have a telling impact on one’s portfolio.
Electronic copy available at: http://ssrn.com/abstract=1328822
Foreign Currency Convertible Bonds- A Legal Perspective Jurisdiction of Laws, Events of Default and Remedial Options FCCBs are required to be issued in accordance with the scheme viz., "Issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depositary Receipt Mechanism) Scheme, 1993”, and subscribed by a non-resident in foreign currency. Such FCCBs are convertible into ordinary shares of the issuing company in any manner, either in whole, or in part, on the basis of any equity related warrants attached to debt instruments. The policy for External Commercial Borrowings issued by the Reserve Bank of India, and amended from time to time is applicable to FCCBs. The issue of FCCBs is also required to adhere to the provisions of Notification FEMA No. 120/RB-2004 dated July 7, 2004, as amended from time to time. However, issue of such instruments is not limited to a single jurisdiction of laws. A FCCB issue involves many other parties like the trustee, paying and conversion agent, registrar, etc. and related documents to a FCCB issue like trust deed, subscription agreement are governed by the laws of the country in which the trustee is situate. Henceforth it stands implied that any default by an FCCB issuing company situate in India would trigger a complex implementation of multiple statutes. Locus Standi of the Aggrieved Party A concern to be addressed in this respect is who are eligible to sue the issuer companies. Regarding the ways to resolve such a query we must resort to commonly appearing clause in every FCCB related prospectus, which is as follows: At any time, after the Bonds become due and payable and amounts in respect thereof remain outstanding, the Trustee may, at its discretion and without further notice, institute such proceedings against the Issuer as it may think fit to enforce the terms of the Trust Deed and the Bonds, but it will not be bound to take any such proceedings unless (i) it shall have been so directed by an Extraordinary Resolution or so requested in writing by Bondholders holding at least 25 per cent. of the principal amount of the Bonds outstanding and (ii) it shall have been indemnified and/or provided with security to its satisfaction. No Bondholder may proceed directly against the Issuer unless the Trustee, having become bound to proceed, fails to do so within a reasonable time and such failure is continuing and no direction inconsistent with such written request or Extraordinary Resolution has been given to the Trustee during such period by the holders of a majority in principal amount of the outstanding Bonds. With reference to the foregoing it may be concluded that prima facie the unsecured bondholders are not entitled to sue the issuer company with respect to events of default, as the primary onus is on the Trustee. It is only in the event of failure of the Trustee to institute any proceeding, even after direction and / request by such Bondholders who hold 25% of the principal amount of the Bonds that such bondholders may proceed directly against the issuer company. What constitutes “Events of Default”.
rescheduling or other readjustment of its debts generally. but for the provisions of any applicable law. execution or any similar proceeding is levied or enforced upon or sued out against any of the chattels or property of the Company and in any of the foregoing cases is not discharged within twenty one (21) days. or . consolidation. • if default is made in the payment of principal. and such default continues for a period of ten (10) calendar days. or if an encumbrancer takes possession or an administrative or other receiver is appointed of the whole or any material part of the undertaking or assets of the Company or if a distress. whether at maturity or on redemption or otherwise. or the Company or any Principal Subsidiary suspends making payments (whether of principal. reorganization or other similar arrangements on terms approved by an Extraordinary Resolution of the Bondholders). In accordance with the terms and conditions of FCCBs and as reflected generally in most of the offering circulars relating to the same. or if so directed by an Extraordinary Resolution of the Bondholders shall (subject always to the Trustee having been indemnified and/or provided with security to its satisfaction) give notice to the Company that the Bonds are. or if the Company or any Principal Subsidiary becomes unable to pay its debts as they fall due or the value of its assets falls to less than the amount of its liabilities (taking into account for both these purposes its contingent and prospective liabilities but excluding any liability in respect of the Bonds).But what may be the possible reasons as to why bondholders may sue such issuer companies. merger. the following clause usually determines as what may be the possible events resulting in a material default by the Issuer companies. these Conditions or the Trust Deed or if any event occurs or any action is taken or fails to be taken which is (or. premium (if any) or interest. If any of the following events (an Event of Default) occurs and is continuing. or if the Company stops or threatens to stop payment generally or ceases or threatens to cease to carry on the whole or substantially the whole of its business. the Trustee in its discretion may (but shall not be obliged to) and if so requested in writing by the holders of at least 25 per cent of the principal amount of the Bonds then outstanding. or the Company or any Principal Subsidiary otherwise becomes insolvent. would be) a breach of any of the covenants contained in Condition 14 and in any such case such failure continues for the period of thirty (30) days next following the service on the Company of a notice requiring the same to be remedied. proposes or makes a general assignment or an arrangement or compensation with or for the benefit of its creditors. if the Company fails to perform or observe any of its other material obligations under the Bonds. premium or interest (if any) due on the Bonds or any of them on the due date. and they shall immediately become. if any) with respect to all or any class of its debts or announces an intention to do so or proposes or makes any agreement for the deferral. due and payable at their Accreted Principal Amount. or • • • • • if any order by a court of competent jurisdiction is made or an effective resolution passed for winding up or an administration order is made in relation to the Company (save for the purpose of amalgamation.
• • if any event occurs which under the laws of any relevant jurisdiction has an analogous effect to any of the events referred to in any of the foregoing paragraphs. Positive covenants place affirmative actions to be undertaken by the issuer company like redemption. (iii) where it appears on the face of the proceedings that the judgment is founded on an incorrect view of international law or a refusal to recognize the law of India in cases in which such law is applicable. (iv) where the proceedings in which the judgment was obtained were opposed to natural justice. (v) where the judgment has . The purpose is to ensure that the borrower. Few of such covenants are discussed as follows: Negative Pledge A negative pledge is a provision which prohibits a party to the contract from creating any security interests over certain property specified in the provision. Section 13 of the Civil Code provides that a foreign judgment shall be conclusive regarding any matter directly adjudicated upon except: (i) where the judgment has not been pronounced by a court of competent jurisdiction. The Trustee and the Agents shall not be required to take any steps to ascertain whether an Event of Default or any event which could lead to the occurrence of an Event of Default has occurred and shall be entitled to assume that no such event has occurred until they have received written notice to the contrary from the Company. it is unlikely that an Indian court would enforce foreign judgments if it viewed the amount of damages awarded as excessive or inconsistent with public policy. etc. On the other hand. A party seeking to enforce a foreign judgment in India is required to obtain approval from the RBI to execute such a judgment or to repatriate any amount recovered outside India. 1908 (the "Civil Code'') on a statutory basis. notifying the bondholders and / trustee on any change in the company. cannot It is observed that any sort of failure by FCCB issuing companies to redeem the outstanding amount of the FCCBs. (ii) where the judgment has not been given on the merits of the case. or breach of any covenant by the issuer company which is directly or indirectly related to the issuer company triggers an “event of default” Recognition of Foreign Judgment & Impact on Bondholders Recognition and enforcement of foreign judgments is provided for under Section 13 of the Indian Code of Civil Procedure. been obtained by fraud and (vi) where the judgment sustains a claim founded on a breach of any law in force in India. Terms and Conditions of the Foreign Currency Convertible Bonds in favor of the Investors There are certain positive and negative covenants applicable on the issuer companies which actually protect and preserve the interest of the investors. Furthermore. negative covenants gives more power to the bondholders to preserve their interest in the company. It should also be noted herein that it is unlikely that a court in India would award damages on the same basis as a foreign court if an action is brought in India. conversion. repurchase. having taken out an unsecured loan.
cheap issuances of additional common stock. Clauses like “Extraordinary Dividend and Cash Protection” and “Conversion Price Adjustment” is an anti dilutive clause and protects the investor from both percentage and economic dilution. Absent contractual protection. But it should also be noted here that unsecured bonds will rank the same in terms of other existing unsecured loans in a company. securing the subsequent loan on the assets of the company. This is a kind of protective clause allowing the bondholder to demand .”. If the borrower could do this. In the absence of anti-dilution protection. which means senior unsecured debt. the liquidation preferences are as follows: Primary Secondary Creditors Secured Creditors 1 2 Unsecured Creditors Senior Junior 3 4 Capital Structure Preference Share Holders Equity Holders Holders 5 Bondholders 6 Event Risk Covenant A provision of the bond which makes the instrument puttable to the issuer following a change of control or a restructuring which reduces the credit quality of the issue. In the absence of other senior unsecured debt. and distributions of cash or property. In the event of liquidation of the issuer company. It is otherwise known as a senior security. This clause corroborates the fact that such bonds rank above other unsecured loans or securities. In the case of default. Anti-dilution provisions are designed to protect the bondholders against dilution from a large variety of corporate events. the original lender would be disadvantaged because the subsequent lender would have the first call on the assets in an event of default. percentage dilution will occur merely through the issuance of additional shares of common stock or securities convertible for common stock and economic dilution will occur as a result of a decrease in the value of the investment. “the conversion privilege attached to a convertible obligation is subject to dilution and change at the will of the corporation. Therefore. unsubordinated debt is less risky than subordinated debt. such bonds will rank in priority amongst the unsecured loan category. amongst others. stock dividends and splits.subsequently take out another loan with a different lender. creditors with unsubordinated debt would get paid out in full before the junior debt holders. Status of the Bonds The bonds are usually unsecured and unsubordinated. Anti Dilutive Clauses Many actions can have a dilutive effect on outstanding convertible securities. including.
conversion of bonds into equity is not in the interest of bondholders and they will prefer the Bonds to get redeemed. Loan from Foreign Equity holder . the trustee of the bonds and the bondholders on any material change in the operations of the company. With other macroeconomic factors prevailing in the scenario. 2. Redeem FCCBs with to respect to fresh borrowings Reset the conversion price and bring it closer to reality Redemption arrangement with bondholders Replacing FCCBs with other innovative/ suitable financial instruments Liquidation of Company and pay to bondholders 1. the various options available to the issuer companies and / bondholders are as follows: 1. creates significant leeway for the party that has inserted that condition to avert liability arising out of the issuer company entering into any such transaction that may be prejudicial to the interest of the bondholders Information Rights The key concept behind such covenant is “suppressio veri” or “suppression of truth”. 3. wherein the current market price of equity underlying of such FCCBs has come down to half or even less of the conversion price of these FCCBs. Redeem FCCBs with fresh borrowing Refinancing of Existing External Commercial Borrowing In terms of the existing Master Circular on External Commercial Borrowings and Trade Credits issued by the Reserve Bank of India on 1st July 2008. slow growth rates. This mechanism provides the platform to the bondholders to keep them updated as to the position of the company and guides their future actions in relation to their holding. “poison put” bondholders can threaten to either force the company into a reorganization or to raise its borrowing costs. Such a decision solely lies in the hands of the Company but is subject to approval of the existing bondholders. such Indian companies which issued FCCBs may fail to generate such cash flows. which may corroborate the redemption of the Bonds. The issuer company is legally obliged to inform such stock exchanges wherein their bonds and shares are listed. In times of low liquidity for a company. existing ECB may be refinanced by raising a fresh ECB subject to the condition that the fresh ECB is raised at a lower all-in-cost and the outstanding maturity of the original ECB is maintained. Options available to Bondholders In this era of bull run and simultaneous demise of Indian stock markets. Affirmative Approval Clause Requiring the approval of the bondholders.repayment in the event of a hostile takeover. 5. But if such an unexpected scenario comes into the forefront. etc. 4. like global recession. The company also provides its financials on a quarterly or semi annual or annual basis to all the parties referred above. falling value of Indian Currency.
resetting of the clauses may seem to change all that. partly converted into shares and partly redeemed. In accordance with the terms and conditions as envisaged in most of the offering circulars. Pushing for additional equity to finance the issues has also been made difficult by the overhang of current debt. Redemption / Conversion / Repurchase Option to be exercised by the Company Conversion Option If the existing capital market scenario recovers. the proposed ECB not exceeding four times the direct foreign equity holding). but they still seem to be in minority. But not all convertible bonds have reset clauses. etc. no investor would convert such bonds into shares unless and until there is a conversion price reset. It’s not that this arrangement comes without a cost. It should also be taken into consideration that early redemption of Bonds is subject to RBI approval. that’s better than the prospect of having to raise funds afresh to repay the convertible bond holders. Repurchase Option . 2. have been corrected by over 40%. non-conversion would lead to a huge hole in the books of accounts. If the bondholder is of the perception that the existing market scenario may improve wherein the converted bonds (actually shares) could be sold in the secondary market. but naturally offering far higher interest that would also dilute equity (in the case of FCCB). the dilution in equity will be much higher. if the price of the underlying shares of a company is below the conversion price. However. Unless the share prices of these companies recover in 24 months. it had been assumed that Indian companies may end up with much more debt than it had planned. investors are unlikely to opt for the equity option.A "foreign equity holder" to be eligible as “recognized lender” of funds amounting to and above USD Five Million under the automatic and / approval route would require a minimum holding of 25% equity in the borrower company and debtequity ratio not exceeding 4:1 (i. However. But such a matter is subject to absolute discretion of the bondholder. As the maturity dates advance. However. the Bondholders may do the same. such a restructuring would attract other provisions of law like takeover code. However.e. only a handful of issuers decided to go for these clauses. the bondholders may get their bonds. Reset the conversion price and bring it closer to reality Share prices of a large proportion of FCCB issues. But. The recent instances of resets indicate that the proportion has increased since then. issuer companies may exercise their call option to get the bondholders convert the bonds into shares. companies have the option of raising additional debt—plain vanilla or again as FCCB. And considering that companies do not show the related interest cost on convertible bonds in the profit and loss statement. In the event an issuer company dilutes a part of its shareholding in the manner aforesaid. FIPB approvals. Prior to May 2006. the debt ratio becomes significant as a means to pay off the FCCB. Thus. On account of the drop in conversion price. and the fresh equity holder may pull in debt to redeem the company’s already existing debt.
If the tenure of the fresh ECB is co terminates with the existing ECB (in the form of FCCBs) and is less than three years. 9/4/2008-ECB dated 6 December 2008. Repurchase should be routed through the Authorized Dealer for the FCCB Issuer Companies should open escrow account with the branch of a subsidiary of an Indian bank overseas or an international bank to ensure that the funds are used only for the buyback. • • • Applicable to both (a) automatic route and (b) approval route.01 Million as on September 2008.59% on 8/12/2008) plus 200 bps. F. Out of a total 153 FCCBs.65 Billion Dollars at rates ranging between 500 to 600 bps above USD 6 Months LIBOR. the Government has indeed responded to the apprehension of a possible default in the repayment of the existing and outstanding foreign currency convertible bonds. In our opinion it is highly unlikely that most of the issuers which are much smaller in Balance sheet size than Reliance can raise funds at much finer rates. Vide Press Release issued by the Ministry of Finance. But. all in cost ceiling should not exceed 6 Months dollar LIBOR (2. the funds used for the same. Premature purchase is allowed only on or before 31 March 2009. Only the issuer can initiate repurchase of bonds. Repurchased bonds must be cancelled and cannot be re issued or sold.To our expectation. the Government has allowed Indian companies to repurchase / buy back of the outstanding FCCBs. represents either of the following: • • Existing Foreign Currency Funds held abroad.59% while as per RBI‘s latest data available 49 companies have borrowed USD 2137. the following conditions must be complied with: • • Such ECBs may be raised with existing ECB norms. Thus the upper ceiling works out to a mere 4. Repurchase of FCCBs under the automatic route is allowed for cases where. • • • • • . The FCCBs to be repurchased should be subject to a minimum discount of 15% on the Book value. currently most of them are quoting below 15% on the book value. subject to the following conditions. Under the Automatic Route there is no limit or ceiling as to the repayment amounts. as is applicable to short term borrowing. No. actual prepayment mechanism is subject to bondholders’ approval. Existing Foreign Currency Funds held in India • Existing Foreign Currency Funds held in EEFC accounts • If fresh ECBs are raised for repurchase of FCCBs under the Automatic Route. India’s top corporates like Reliance has raised nearly 1.
companies can redeem the full outstanding amount. to modify or cancel the Conversion Right or shorten the Conversion Period. Such amount shall not exceed USD 50 Million of the total redemption value of the outstanding FCCBs per company. However such a corporate action is always subject to approval from the bondholders. Demerger or Any Other form of Arrangement One of the best proven strategies to offload debt liability on the balance sheet of the original issuer company is an amalgamation / merger with possible entities . • Under the Approval route. In case of severe crisis. The business of such a meeting may include consideration of proposals. in which case the necessary quorum will be persons holding or representing not less than two-thirds. or to modify the provisions concerning the quorum required at any meeting of Bondholders or the majority required to pass an Extraordinary Resolution. to reduce or cancel the principal amount of or premium or rate of interest (if any) on the Bonds. to change the currency of payment of the Bonds. The FCCBs to be repurchased should be subject to a minimum discount of 25% on the Book value. This creates a ceiling on the amount to be repaid to the Bondholders. inter alia. or at any adjourned meeting persons holding or representing not less than one-third. and not with any fresh Indian currency loans. This is to be noted here that Buybacks under the Approval Route can be only done with internal accruals of the issuer companies. in principal amount of the Bonds for the time being outstanding. • 4. subject to the following conditions. Other forms of restructuring Amalgamation. • • • • • • to modify the maturity of the Bonds or the dates on which interest (if any) is payable in respect of the Bonds. Redemption arrangement with bondholders Modification and Waiver Any trust deed in relation to any FCCB usually contains provisions for convening meetings of existing bondholders to consider matters affecting their interest. including the modification of any of the conditions or any provisions of the trust deed. followed by subsequent slump sale of the same which in turn may provide the funds to repay the existing loans. . issuer companies may resort to Demerger / divestiture of any of their unit.Under possible circumstances. • Rupee resources representing internal accruals to be evidenced by Chartered Accountants and / certificates from designated Authorized Dealers. Government Incentives 3. Indian companies are allowed to repurchase out of rupee resources.
and such acquiring company may actually undertake to takeover the issuer company. If any of the Indian Courts view the amount of damages to be awarded as excessive or inconsistent with public policy. But. But it must be noted here that such an action would trigger multiple actions as follows: 1. the Company may opt to convert such bonds into shares and subsequently buy back such shares from the Investors. it is very much probable that the Indian Courts may not allow such enforcement of foreign decree or judgment.The existing ECB may be paid for the time being. in aspects like usage of ECB to refinance existing Rupee Loans. In the first and the more efficient case of voluntary liquidation. Liquidation / Restructuring of Company and pay to bondholders If an issuer company fails to honor its commitment to pay off such redemption amount. In accordance with the provisions of any existing trust deed in relation to an issue of foreign currency convertible bonds. Substitution of Original Obligor A very effective mechanism may be to substitute the original obligor. despite the Bondholders seeking immediate payment. To enforce a foreign judgment relating to repatriation of any amount recovered outside India. Liquidation under Companies Act Under the Indian Companies Act. shareholders vote for liquidation and hand over . the matter may go to international courts seeking liquidation of assets towards repayment to the creditors. Obtaining a foreign judgment in an international court of law. Execution petition in an Indian court to approve the same. 5. on account of the request of companies who have issued such foreign currency convertible bonds and due to Government liberalizing the existing policies related to external commercial borrowings. Such petition may be forwarded to National Company Law Tribunal who would determine the consequences. Conversion and Buyback After resetting the conversion price. against the company. Converted bondholders may sell such shares (converted bonds) to any existing competitor of the issuer company. prior approval is required from the RBI. this is too much of a contingent strategy and henceforth cannot be waited upon. 2. 5. keeping in view the current market conditions. the issuer company may substitute any other company (the “Substituted Obligor”) in place of the Company as the principal debtor under the trust deed for redemption of the bonds. 3. This will create a massive dilution to the extent that existing shareholders may face inevitable circumstances to file cases of oppression and mismanagement under the law. 4. liquidation of a company facing financial distress can be accomplished via two modes: voluntary liquidation by creditors or involuntary liquidation by court.
500 of unpaid and undisputed debt. Restructuring under Companies Act Restructuring under the Indian Companies Act is limited to either a merger & acquisition strategy or a voluntary compromise arrangement between the company and the creditors if a change in the capital structure (changing debt for equity or reducing equity) is warranted as part of the compromise.” which would make the compromise binding without the approval of the requisite block of creditors. However it should be noted here that Section 44A of the Civil Code is applicable only to monetary decrees or judgments not being in the nature of any amounts payable in respect of taxes or other charges of a like nature or in respect of a fine or other penalty and shall in no case include an arbitration award. In the second case. So unsecured foreign creditors may file a petition under Section 390 to 396 of the Companies Act. which has the power to supervise the implementation of the compromise. a creditor with a minimal amount of Rs. can petition the court for involuntary liquidation. even though Section 44A of the Civil Procedure Code provides that where a foreign judgment has been rendered by a superior court within the meaning of that section in any country or territory outside India which the Government of India has by notification in the Official Gazette declared to be in a reciprocating territory for the purposes of Section 44A. 1956 . 2. even if such an award is enforceable as a decree of judgment. who then hire a private or an official liquidator to oversee the asset sales and distribution of proceeds. after giving three weeks’ notice to the debtor. the court’s actions are purely discretionary and “the court may refuse to hold the company insolvent on other considerations including that of public interest”. in which case. government. it may be enforced in India by proceedings in execution as if the judgment had been rendered by the relevant court in India. management. Insolvency & Liquidation The Indian Companies Act does not distinguish between domestic and foreign creditors in so far as winding up of a company is concerned. the court will determine the validity of the claim and the reasonableness of the petition before ordering liquidation. There is no provision similar to a “cramdown. Methods of Dispute Resolutions and Litigation and Arbitration Most of the offering circulars relating to FCCBs stipulates a fact that India is not a party to any international treaty in relation to the recognition or enforcement of foreign judgments. However. official liquidator) but has to be approved by creditors (majority in numbers and three-fourth in value) and confirmed by the court.control of the liquidation process to secured creditors. The compromise arrangement can be proposed by any party (creditors. the liquidation and reorganization petitions here are not necessarily sequential and either proceeding can trigger the other at any time until an order for liquidation is passed. Also. Conventional Drawbacks 1.
Many provisions of SICA have been incorporated in Chapter VI A (Section 424A-424L) in a considerably diluted form. Sick industrial company means an industrial company (being registered for not less than 5 years) which has at the end of any financial year accumulated losses equal to or exceeding its entire net worth. The same shall be filed with the NCLT who would then govern such proceedings and accordingly instruct the likewise. The lacunae of implementing cross border insolvency laws may prove to be a threat to the unsecured Bond Holders. The work of revival and rehabilitation was entrusted to National Company Law Tribunal (NCLT) constituted under the Companies Act. 2003. 1956. first in 1991and later in 1998. As far as the litigation matter is concerned. in terms of Section 2(46AA) of the Companies Act 1956. In terms of the erstwhile Sick Industrial Companies Act 1985 (SICA). On event of consecutive defaults by FCCB issuer companies. Any appeal against the order of the NCLT will now be made to the NCLAT instead of Appellate Authority for industrial and financial reconstruction. Sick industrial company means an industrial company. the same may be subject to fall under the definition of “sick company”. if a judgment holds good in the eyes of the Indian Judiciary and falls within the ambit of Section 44A of the Civil Procedure Code. it should be noted here that unsecured creditors who may have filed suits or obtained decrees shall be deemed to be of the same class as other unsecured creditors. or • has failed to repay debts to its creditor(s) in its previous 3 consecutive quarters on demand made in writing for such repayment. If such Issuer Companies becomes sick companies. Further. the Bondholders may exercise their security interest in respect of the secured / charged assets. On the other hand in the matter of unsecured bonds. In the matter of non reciprocating territories. However. In the event a Company issued Secured Bonds. was repealed and replaced by Sick Industrial Companies (Special Provisions) Repeal Act. we understand that in the matter of reciprocating territories. which has at the end of any financial year: • accumulated losses exceeding 50% of average net worth during last 4 years. So under Section 390 of the Companies Act. The basic . which is the highest authority to determine such cases. foreign creditors who may have obtained any decree or initiated a proceeding abroad . However. unsecured creditors would require to arrange a statutory “meeting” with the company under Section 391 of the Companies Act 1956. The suit must be brought in India within three years from the date of the judgment in the same manner as any other suit filed to enforce a civil liability in India 3. such petitions or proposals of arrangement between the creditors and the company are filed with National Company Law Tribunal. This and after being amended twice.in accordance with the existing guidelines. the execution of such decree or judgment may be proceeded with. would be deemed to be categorized under unsecured creditors. a judgment in a court of such jurisdiction may be enforced only by a new proceeding initiated in a court in India.
the High Courts. Aurobindo Laboratories. Bajaj Hindustan. many Indian Companies have favored and utilized the FCCB route to tap cheap overseas funds. in this stringent market scenario. Suzlon and Amtek Auto. dilatory tactics used by the management and workers such as litigating the BIFR decision and not providing appropriate financial records. LML. Orchid Chemicals. the process of disposing of assets and settling claims is very lengthy because of the involvement of the government and judicial system.premise of the provisions incorporated in Chapter VI A of the Companies Act is to plug the loopholes in the erstwhile SICA. the Company Law Board. Companies which had taken the FCCB route to finance their growth plans and which currently expect maturity of those bonds include Wockhardt. is also a cumbersome process riddled with endless loops of procedural delays. Several companies came out with such FCCB issues in the years 2004 and 2005 and subsequently these companies are pending their turn to convert such bonds issued by them into shares or retiring the bonds with the proper redemption amount. Once a recommendation for liquidation is made by the appropriate agency. have overlapping jurisdiction. Sakthi Sugars. 3i InfoTech. four different agencies. Subex Azure. and the Debt Recovery Tribunals (DRTs). The commonly cited reasons for the delays include sheer workload (40 cases are reviewed each month). First Source. Hotel Leela. the Board for Industrial and Financial Reconstruction (BIFR). natural fears have risen about potential default by Indian corporate issuers. HCC. 4. and lack of cooperation from creditors when asked to make concessions. Although data are not available to accurately estimate the costs involved in reorganizing or liquidating a firm’s operation. Ambiguity in Indian Corporate Bankruptcy Laws Companies Act. Bharat Forge. As a result. Conclusion There is no single comprehensive and integrated policy on corporate bankruptcy in India comparable with the Chapter 11 or Chapter 7 bankruptcy code in the US. 1956. Investors who have invested in the bonds are anxious over the fact as to whether their investments would stand redeemed or not. Considering the huge amount at stake. we can easily surmise the time value of money costs (erosion of ~ 50 per cent of value) due to the time intensive nature of the process for reorganizing or liquidation under the SIC Act. The aim not only to combat industrial sickness but also to reduce the same by ensuring that companies do not view declaration of sickness as an escapist route from legal provisions after the project failure and gaining access of various benefits & concessions from the financial institutions. and which in turn have affected the Indian stock market. . There are three major legislative Acts and several special provisions. which provide procedural guidance on the liquidation or reorganization process. The process of liquidation under the jurisdiction of the Prior to the recessionary phase which took over the entire global economy. Tata Motors. which creates systemic delays and complexities in the process.
In reality other than redemption and conversion of the bonds. The Government of India is supposed to be working on liberalization of such regulations. Most of the companies are now faced with the option of striking a settlement with bondholders at a discounted price. Companies who have recently issued FCCBs and the respective bondholders are insulated well enough from such crisis scenario. rules and norms as would be deemed fit. At the time of Repayment/Conversion the issuer can either refinance the whole issue and roll-over the amount or repay the amount in total. The fact that Indian markets being endowed with efficient and rapid recovery should be of solace to the investors. for the recovery of this current scenario. Investors should be assured that India would not like to take the blame of the “Millennium’s Worst Defaulter”. during which Indian economy is deemed to recover. Foreign Debt and Equity has contributed a lot in the development of modern India and acknowledging the same. . Such circumstances may also witness the intervention of the Government who would assist such issuer companies to retire their obligations. agreeable to the creditors and the other option is bringing in an outside investor who would buy the bonds. Since liquidation of companies in India is a cumbersome process. most of the Indian companies would prefer to redeem the bonds under whatsoever circumstances and liquidation suits should be the last resort. Many such companies intend to rope in private equity investors and funds to bail them out of the crisis caused by possible redemption.Unfortunately. India is not a party to any international treaty for enforcement of foreign judgement and most of offering circulars are governed by English law even though any judgment of higher court in reciprocating territory will be enforced in India. and enable the issuing companies to again tap the market for funds. Under the Indian legal system the issuer companies can never default absolutely in repayment of the bonds. According to sources. because their redemption or conversion dates are pending such a tenure. This will give enough legal support for Bondholders but implementing cross border laws and with prior permission from RBI to execute foreign judgement in India for damages is again a cumbersome process. Many investors are looking at options to convert a part of the bonds into equity to improve the debt equity ratio. share prices across Indian companies have crashed and it looks like most Indian companies will have to pay back the debt because no investor will want to buy shares at a high price (pre-fixed earlier) when they can buy them from the market at throwaway prices. the investors are otherwise entitled to other settlements like allowing such issuer companies for restructuring and creditor’s arrangement like Essar Steel Limited has extended maturity of the international instrument (Notes) issued in 1996 to prevent defaults in repayment during financial crisis in 1999. Otherwise in reality that may disrupt the nation’s future inflows from the international market. the government is aware of the issue and is internally discussing ways to prevent a scenario of companies defaulting on repayments.
we have suggested a few alternative options available to the companies and / bondholders rather than the typical conventional procedures. It should be noted in this aspect that there may be more alternatives other than the ones we have suggested. amidst this wake of financial crisis and increasing investor anxiety.neither the Indian corporates nor the Indian government would allow any mishap in the repayment of the bonds. . However.
Because the option is not likely to be exercised. in which the authorized issuer owes the holders a debt and. they tend to benefit from price appreciation in the underlying common stock. Post issuance of foreign currency convertible bonds. a detailed scrutiny would reveal the existence of the following more options. In addition. Prima facie. these securities generally trade similarly to regular bonds and are usually characterized by high yields and high conversion premiums. These securities are generally characterized by low yields. low conversion premiums and a tendency to move in tandem with the underlying stock. In contrast. it may look like a straight bond with an warrant option. A common strategy involving convertibles trading in this range is to swap out of an equity that has had a significant run-up in value and into the associated convertible bond or preferred. Although the trading range varies from security to security. convertible bonds are generally divided into one of three categories: 1) Hybrid/total-return investments 2) High-yield/straight-debt alternative 3) Equity substitutes. Investors typically use equity substitutes to secure a higher yield than that provided by the common stock’s dividend. the price of the underlying stock is far below the conversion price. 1. Straight Debt Option Simply put. Convertibles that trade close to the conversion price are called hybrid/total-return investments and often exhibit all the qualities that make convertibles attractive. they have achieved the status of all such categories referred above. which indeed makes ii worth discussing.Embedded Options in Foreign Currency Convertible Bonds Dissection of foreign currency convertible bonds as is necessary to understand the pros and cons involved with its reveals the existence of multiple options embedded in it. However. depending on the terms of .” Convertibles trading in this range most effectively demonstrate the asymmetric return characteristics that make convertible securities an attractive asset class. a bond is a debt security. A highyield/straight-debt alternative can be characterized as a convertible containing a conversion option that is significantly “out-of-the-money” – that is. the convertible is considered an equity substitute. When trading near their conversion price. while still enjoying some downside support provided by their fixed income components. exercisable before maturity of the instrument. when the price of the stock underlying a convertible bond is significantly above the conversion price. these convertibles typically trade between 80% and 110% of par. High-yield/straight-debt convertibles are typically sensitive to changes in interest rates and the issuer’s credit quality. these securities offer stronger principal protection should the stock price fall significantly. In general. benefiting from the “best of both worlds.
but prior to the maturity date to get their bonds converted into shares. termed maturity. The maturity of many of the FCCBs is expected to start in October 2009 and peak in 2010-11. which has trimmed some mid.and mid-sized companies. This leaves them with two options.and small-cap stock values by 70-80 per cent. The only alternative is to make it more attractive for bondholders to opt for conversion. The bond holder receives the full principal amount on the redemption date. . Indian companies that raised large sums of foreign funds to finance growth and acquisition plans during the bull run in the stock markets are in a Catch 22 situation. In the secular bull market from 2003 to 2007. as more shares now have to be issued to raise the same quantum of funds. 2. Conversion Put Option The Bondholders may put their bonds anytime. the issuer is the borrower. Indian companies resorted to funding their growth plans through FCCBs in large numbers. But the current liquidity crunch and the market meltdown have taken the wind out of their sails. In the past few years of strong economic growth. FCCBs were usually issued under the assumption that holders would opt to convert bonds into the issuing company’s shares. FCCBs are raised as debt. The other is to redeem the bonds. and the coupon is the interest. In a bull run this poses no problem as the market reaches the value of the share before the bond matures. sometime before the bonds came up for redemption. There are multiple cases wherein the outstanding amount on account of FCCBs is higher than or around the current market capitalization of the companies. but carry an underlying conversion option into equity before they mature. They are issued at a substantial discount to par value. as the value of the shares dip below the conversion price. Thus a bond is a loan. The conversion price is set at a premium to the current market price of the company’s shares. Most of the foreign currency convertible bonds are zero coupon bonds. This means more equity dilution. as they don't pay any interest. such debt may be well beyond their means.the bond. Conversion prices were set at a hefty premium. by offering a much more attractive swap price. a move that could dilute promoter holdings (since it would entail issuing more equity shares). With bondholders showing no inclination to convert. This house of cards has come tumbling down with the unexpected market meltdown postJanuary 2008. This is a very new ballgame for the Indian corporate sector. One is to reset the price at current market price. is obliged to pay interest (the coupon) and/or to repay the principal at a later date. which could increase debt obligations that are already substantial in some cases. The conversion price of their foreign currency convertible bonds is several times higher than their current market prices. For some small. the bondholder will exercise the debt option. Most analysts say the market is unlikely to recover so significantly over the next two years that market prices will match the conversion prices. offering bondholders an attractive exit opportunity. the bond holder is the lender. rising share prices and lower interest rates. based on the assumption that stock prices would continue to rise. But when markets tank. issuers may be forced to honor their FCCB liabilities as borrowings when they come up for redemption.
convertibles offer investors a defensive way to invest in equities. Redemption Call Option In the absence of a hard call protection. and convertible investors have unsecured claims on a company’s assets providing them a higher recovery value than common stock holders in a liquidation. While past performance is no guarantee of future results. This is a consequence of the event risk covenants. Such options may be exercised in two or more specific events like. If the outstanding principal amount is 10% of the total amount of the bonds. . Most convertible bonds pay investors a fixed income stream that is greater than the yield on the underlying common shares. RBI regulations at the time of redemption may require the Issuer to obtain the prior approval of the RBI before providing notice for or effecting such a redemption prior to the Maturity Date. thus making them an effective product for portfolio diversification. It should be noted that such option cannot be exercises by the issuer company before such date which has been prescribed by the Reserve Bank of India to be the minimum maturity date. 4. or Puttable Bonds.” Convertibles are senior to common shares in a company’s capital structure. There is an embedded feature of the bonds that permits the holder to sell the bonds back to the issuer at such value deemed fit at that point of time. which is provision of the bond which makes the instrument puttable to the issuer following a change of control or a restructuring which reduces the credit quality of the issue.3. However. Convertible securities allow investors to participate in a company’s stock price appreciation while providing them some amount of downside protection against a decline in the underlying common stock’s share price. called “yield advantage. which entitles the company to force the bondholders to retire the outstanding bonds. “poison put” bondholders can threaten to either force the company into a reorganization or to raise its borrowing costs. Redemption Put Option Bonds with these options are usually called Put Bonds. studies indicate historically that convertible securities have produced near-equity returns over the long term while assuming less risk. in case of the following events. • • • Change in Control of the Issuer Company Change in Taxation Policies in the economy of the Issuer Company Delisting of the Issuer Company • • If the Share Prices elevate to a certain amount and maintains the consistency for a definite time period. Puttable Notes. this is an exclusive option available only in the hands of the Issuer company. In times of low liquidity for a company. Consequently. This is a kind of protective clause allowing the bondholder to demand repayment in the event of a hostile takeover. Such minimum maturity date depends upon the total quantum of the bonds issued.
some corporate actions such as name change or change in the registered office of a company have no direct financial impact on the shareholders. So many . return of capital. Another example is a call (early redemption) of a debt security. Other corporate actions such as stock split may have an indirect impact. In all the cases cited above the shareholder is just a passive beneficiary of these actions. etc. thereof. Otherwise. bonus issue. division.Impact of Corporate Actions on outstanding Foreign Currency Convertible Bonds A corporate action is an event initiated by a public company that affects the securities (equity or debt) issued by the company. most of the offering circulars related to issue of foreign currency convertible bonds. respectively. Since a company is bound by restrictive covenants to the bondholders. Other examples of mandatory corporate actions include stock splits. consolidation and reclassification of Shares. yet their approvals are required to enforce the same. However. There is one such mandatory action which a company may exercise upon its bondholders and that is a “hard call” to get the bonds converted into shares. as the increased liquidity of shares may cause the price of the stock to rise. stress upon the fact that the Conversion Price will be subject to adjustment in the event of free distribution. A Bondholder may not be willing to get the bonds converted and rather opt for coupon payments/ redemption amounts at that point of time. spin offs. This is especially true with full-ratchet anti-dilution protection because the issuance of even one share will result in an adjustment of the conversion price of all the existing bonds. Strictly speaking the word mandatory is not appropriate because the share holder per se doesn't do anything. This is because of the presence of restrictive covenants in the agreements entered by the Company with the creditors. In general. It should be noted herein that even though creditors of a company do not participate for such corporate actions. Mandatory and Mandatory with Choice corporate actions and we would like to discuss the role of the bondholders in such matters and the consequences. including unsecured bondholders. prerefunding. and a shareholder does not need to do anything to get the dividend. Corporate actions are classified as Voluntary. in the event the share prices reaches up to a specific point. A mandatory corporate action is an event initiated by the corporation by the board of directors that may all the existing creditors of a company. However. mandatory corporate actions may either directly or indirectly affect the interest of the existing bondholders. Some corporate actions such as a dividend (for equity securities) or coupon payment (for debt securities (bonds)) may have a direct financial impact on the shareholders or bondholders. we should first know as to the categories of corporate actions. There is nothing the Share holder has to do or does in a mandatory corporate action. All holders are entitled to receive the dividend payments. An example of a mandatory corporate action is cash dividend. mergers. bonus issue. the company will want to ensure that certain types of stock issuances do not trigger the anti-dilution protection. Participation of shareholders is mandatory for these corporate actions. issue of convertibles like warrants.
Apart from such positive rights. as the market would reaches the value of the share before the bond matures. Share holders may or may not submit their elections. the default option will be applied. the market usually interprets this as a sign that the company's share price is somewhat overvalued. Thus. Making a claim for damages against an “out of money” company may be futile. the corporate actions needs to be approved by the bondholders. To avoid this negative impression. From the investor's perspective. a convertible bond has a value-added component built into it. This means that the company needs to prepare a detailed schedule of exceptions or disclosure schedule to disclose things required by the representations and warranties. it is essentially a bond with a stock option hidden inside. For example. as a practical matter. We may contemplate the stock market to get into a bull marathon. which bondholders will likely convert to equity anyway should the company continue to do well. A response is required by the corporation to process the action.such investors have opted for a soft call option rather than a hard call option prior to investment. The sustained dip in the stock markets has ruined the chances of these companies of offering investors the option of converting the bonds into equity at a premium. if an already public company chooses to issue stock. For example in case of a cash/stock dividend option. there would be no problem. and the corporation will send the proceeds of the action to the shareholders who elect to participate. But if markets do not perform up to the mark. as the value of the shares would stay dipped below the conversion price. the shareholder can elect to take the proceeds of the dividend either as cash or additional shares of the corporation. In addition. . Even in such scenario. the recourse for a breach of representations and warranties generally is a claim against the company for damages. An example of a voluntary corporate action is a tender offer. However a general reference to offering circulars related to bonds would reveal the existence of multiple options in the hands of the issuer company or the bondholders. Other types of Voluntary actions include rights issue. and assuming the share prices of the issuer companies to get recovered in 24 months. Sometimes a voluntary corporate action may give the option of how to get the proceeds of the action. An example is cash/stock dividend option with one of the options as default. In case a share holder dose not submit the election. The shareholder may or may not participate in the tender offer. A Mandatory with Choice corporate action is a mandatory corporate action where share holders are given a chance to choose among several options. the bondholder will exercise the debt option. Issuing convertible bonds is one way for a company to minimize negative investor interpretation of its corporate actions. the bondholders are also entitled to informative and disclosure obligations of the company. A corporation may request share holders to tender their shares at a pre-determined price. Shareholders send their responses to the corporations agents. A voluntary corporate action is an action where the share holders elect to participate in the action. making buyback offers to the share holders while delisting the company from the stock exchange etc. it tends to offer a lower rate of return in exchange for the value of the option to trade the bond into stock. the company may choose to issue convertible bonds.
be able to buy back their bonds at a steep discount. Amidst such global recession. The RBI move permitting Indian Companies who issued FCCBs to buy back their FCCBs was a step in the right direction as it allows Indian corporate treasuries to actively manage their liability mix. once a foreign bank arranged for the FCCBs it entered into a credit default swap with an Indian bank. But the overseas branches or subsidiaries of Indian banks bought credit linked notes (CLNs) which was basically a derivative on the debt part of the FCCB. Large-scale defaults are still unlikely as corporates will look to replace the FCCBs with new debt on maturity but repayments will certainly worsen their balance sheets and the fresh loans will come at high cost. Issue of FCCBs has been simultaneously covered by issue of credit linked notes. banks are not allowed to guarantee FCCBs or ECBs directly. such Buy Back Scheme is allowed only till 31 March 2009 and raising fresh external commercial borrowings. many would be out of money and the probability of re-pricing the issue is high. it will have to book a capital loss. For companies having FCCBs that are to be redeemed next year. it is highly unlikely that Indian companies will get foreign banks’ money to pay back the FCCBs.Buyback Issues of Foreign Currency Convertible Bonds. Companies who intend to buy back such FCCBs both under the automatic and approval route are subject to differential pricing and many companies may shy away from premature buyback of foreign currency convertible bonds (FCCBs) owing to lack of funds. Essentially. in which the Indian bank effectively insured the foreign bank. Buyback under Automatic Route will allow issuers to get into the market and take advantage of whatever limited liquidity is there in the bond market and get that bond off before other investors can go in and buy. The move to permit FCCB buyback out of EEFC dollars accounts and dollars held offshore is appreciable as it will help them take advantage of the distortion in the global credit market. However. Indian banks may be called upon to honor those maturing liabilities. If the Indian companies default then these Indian banks who have subscribed to the CLNs will be in trouble in a big way as . Also. compliance with regulatory procedures in different jurisdictions within constrained time period may add complexity. therefore. According to the Guidelines on External Commercial Borrowings. It should be also noted that several Indian companies who have raised more than USD 500 Million by issuing FCCBs. companies are likely to besiege them for loans to refinance their maturing FCCB debt. FCCBs of most companies are quoting at a discount of 30-70%. it looks like the debt will finally land on the doorsteps of Indian banks. The government is aware of the issue and is internally discussing ways to prevent a scenario of companies defaulting on repayments. Corporates that are eligible and have funds would. That means each time a corporation fails to pay back their FCCB commitment. may require prior approval of the RBI for prepayment.
An issuer can request the names of the beneficial owners of its bonds but whether such request is granted is usually determined on a case-by-case basis. but also involves an offer and sale of new securities. Market purchases may be effected either directly by the issuer or through an agent (usually a bank or a licensed broker/dealer). In a tender offer. However. tender offers and exchange offers. Open market purchases of bonds are generally more appropriate if the issuer intends to purchase only a portion of the outstanding bonds. there are three main ways in which an issuer might repurchase its bonds: market purchases (directly or through a related company or an agent). Buyback of FCCBs can create short-term mismatches from a foreign exchange perspective on a longer-term basis. Aside from amending the terms of an existing series of FCCBs to allow for such buybacks. The offer may be to purchase any and all bonds tendered or to purchase only up to a specified amount. The purchase price might be financed out of the issuer's cash resources.they will lose the principal. An exchange offer is also a tender offer and is regulated as such. the issuer or a third party or agent will offer bondholders to purchase their bonds for cash. it would be foreign exchange neutral. but down the time lane. The setback lies in the fact that as of now the “insurance” rate has gone up to 15% and since Indian banks have to maintain the rate the value of the asset that they have insured has to fall. it should be noted that any large number of buyback moves by Indian Corporates who have issued FCCBs in the recent past. Bondholders would be holding their interest in the bonds (directly or indirectly) through accountholders of the clearing systems and information of the ultimate bondholders would not be revealed by either the clearing systems or the accountholders to the issuer. in the global market. . It would generally only show that the global notes are registered in the name of a common nominee of the clearing systems. The issuer may employ a dealer-manager in connection with a bond buy back who may be able to assist in identifying bondholders. through bank borrowings or through a new bond issue to the market. Assuming that the FCCBs are held in registered global form and cleared through Euroclear and / Clearstream. may create a significant illusion of liquidity and marketability crisis of Indian Corporate Bonds. the register of bondholders would not show the names of the individual bondholders owning interest in the bonds. The issuer would usually offer a higher price than the existing market price of the bonds to make the offer more attractive to holders.
An exchange offer is also a tender offer and is regulated as such. the register of bondholders would not show the names of the individual bondholders owning interest in the bonds. it should be pertinent to understand the modus operandi of the buyback transaction. At this stage when Indian Corporate Borrowers (who have issued Foreign Currency Convertible Bonds in the recent past) are proceeding to repurchase their outstanding debt in the foreign market. Open market purchases of bonds are generally more appropriate if the issuer intends to purchase only a portion of the outstanding bonds. Assuming that the bonds are held in registered global form and cleared through Euroclear/ Clearstream. it is questionable whether the issuer may buy back its bonds under English law. the issuer or a third party or agent will offer bondholders to purchase their bonds for cash. a bondholders' meeting would be needed to pass a resolution allowing the bonds to be purchased by the issuer. through bank borrowings or through a new bond issue to the market. and if provided for in the documents. If the terms and conditions of the bonds do not contain such a provision. The purchase price might be financed out of the issuer's cash resources. There is a tension between. An issuer can request the names of the beneficial owners of its bonds but whether such request is granted is usually determined on a case-by-case basis. Where a market purchase is conducted through an agent. but also involves an offer and sale of new securities. on one hand. the issuer would typically enter into a purchase agreement with the agent pursuant to which the agent would agree to offer to purchase the bonds on the issuer's behalf and then to on-sell them to the issuer at an agreed price. another member of the issuer's group). is for the repurchase to be effected by a third party (e. If this is not possible.Buyback of Foreign Currency Convertible Bonds – Key Considerations Disclaimer: This Bulletin is a summary only and does not constitute any definitive legal advice. The issuer may employ a dealer-manager in connection with a bond buy back who may be able to assist in identifying bondholders. The offer may be to purchase any and all bonds tendered or to purchase only up to a specified amount.g. is whether the decision by the issuer to buy back its bonds is . A major part of the role of the broker/dealer/agent is to identify where the bondholders are located and what restrictions there might be in those jurisdictions in making the offer to those bondholders. It would generally only show that the global notes are registered in the name of a common nominee of the clearing systems. There is normally an express provision in the terms and conditions of English law-governed bonds that an issuer has the power to purchase bonds issued by it. The usual solution in such a case. Bondholders would be holding their interest in the bonds (directly or indirectly) through accountholders of the clearing systems and information of the ultimate bondholders would not be revealed by either the clearing systems or the accountholders to the issuer. the desire to achieve as many acceptances as possible and on the other. The issuer would usually offer a higher price than the existing market price of the bonds to make the offer more attractive to holders. Market purchases may be effected either directly by the issuer or through an agent (usually a bank or a licensed broker/dealer). An important point to consider in the context of an open market purchase. In a tender offer. to restrict the offer in certain jurisdictions in order to prevent the issuer falling foul of local regulations.
On the other hand. therefore.S.. Bondholders' meetings can be convened. it is important to recognize that even if bonds were sold solely outside the United States pursuant to Regulation S. an issuer will need to make a preliminary determination of what percent of its bonds are held by U. to remove certain events of default and covenants. no disclosure is required. Any board authorization relating to the buy back should reflect that any initial purchases are being made on an opportunistic basis as referred to above and in this respect care should be taken. the issuer was contemplating a tender offer. The main advantage of convening a meeting rather than conducting a tender offer or an exchange offer is that if the resolutions are passed by the requisite majority.S. for example. Before planning any buy back. to vote on resolutions to alter the terms and conditions of the existing bonds. . If a company is buying back on a purely opportunistic basis with no firm intention. If. it may then be able to form the view that such decision alone is not price sensitive and. to ensure any instructions given to a broker in connection with such purchases are consistent with the buy back being on an opportunistic basis. Any buy-back exercise is also very likely to affect the price at which the bonds are trading. Issuers buy back bonds before their scheduled maturity dates to reduce outstanding debt or to take advantage of market conditions by replacing existing borrowings which could be expensive or which have unfavorable terms. a substantial portion of those bonds may have flowed into the United States or to U. securities laws in bond buy back transactions depends largely on three factors: (1) a jurisdictional nexus with the U. whether an exemption is available from the registration requirements of the Securities Act. all bondholders are bound.S.itself price sensitive information requiring disclosure. persons. for example. it would place the issuer in a difficult position if it subsequently proceeded with the tender offer at a different price from that at which it completed the proposed market purchase(s). The applicability of the U.S. persons. As an initial matter. and (3) in the case of an exchange offer. without conducting a tender offer or an exchange offer. The purchase by an issuer of its bonds should also be considered in the context of the issuer's overall intentions in respect of the outstanding bonds. then it would not be advisable for the issuer to proceed with any market purchase(s) of such bonds. bondholders may perceive this approach as coercive compared to the voluntary nature of a tender offer or an exchange offer. In particular. tender offer rules. leaving no part of the issue remaining under the old terms. requirement or other commercial imperative as to the price it is prepared to pay for any bonds and the amount of bonds to be purchased (and any board authorizations reflect this).S. for example. or to change the maturity period or the interest margin. (2) whether the issuer is exempt from the U.
In most realistic situations. but that such winding up would unfairly prejudice the . a large parallel black economy has developed in India where transactions are carried out in cash and are not recorded in the books of accounts. but it has the ability to make business judgments. the ultimate resort for a shareholder to enforce his ownership rights. Regulatory Response The Company law provides that a company can be wound up if the Court is of the opinion that it is just and equitable to do so. this is hardly a meaningful remedy as the break-up value of a company when it is wound up is far less than its value as a “going concern”. First.Corporate Governance The recent upheaval on corporate governance in India tends to bring forth the major problem in the Indian corporate sector (be it the public sector. he approaches the court to wind up the company and give him his share of the assets of the company. payments for “services” to closely held group companies and so on. So passive have they been that in the few cases where they did become involved in corporate governance issues. who would often imply a micro-management of routine business decisions which lie beyond the regulators’ mandate or competence. In the Indian business groups. of course. the concept of dominant shareholders is more amorphous for two reasons. they were widely seen as acting at the behest of their political masters and not in pursuance of their financial interests. the promoter may not even be the largest single shareholder. preferential allotments of shares to the dominant shareholder. Second. they can approach the Company Law Board (now proposed to be renamed as the Company Law Tribunal). This allows the promoters to play all the games like structuring of businesses at whims and transfer of assets between group companies. the promoters are effectively dominant shareholders and are able to get general body approval for all their actions. Rather than let the value of his shareholding be frittered away by the enrichment of the dominant shareholder. The Company law also provides for another remedy if the minority shareholders can show that the company’s affairs are being conducted in a manner prejudicial to the interests of the company or its shareholders to such an extent as to make it just and equitable to wind it up. Instead of approaching the Court. the multinationals or the Indian private sector) of disciplining the dominant shareholder and protecting the minority shareholders. the aggregate holding of all these entities taken together is typically well below a majority stake. It is sometimes difficult to establish the total effective holding of this group. What makes the promoters the dominant shareholders is that a large chunk of the shares is held by state owned financial institutions which have historically played a passive role. What aggravates the circumstances are that the regulators face a difficult dilemma in that correction of governance abuses perpetrated by a dominant shareholder. In many cases. The Company Law Tribunal which is a quasi-judicial body can make suitable orders if it is satisfied that it is just and equitable to wind up the company on these grounds. the promoters’ shareholding is spread across several friends and relatives as well as corporate entities. The capital market on the other hand lacks the coercive power of the regulator. This is. So long as the financial institutions play a passive role. In addition. over several decades of the command economy.
Even otherwise. it may not be a sufficient safeguard if the process of conducting shareholder meetings is not conducive to broader participation by a large section of the shareholding public. and has taken a number of initiatives in the area of investor protection. but it is a prerequisite for the minority shareholders to be able to exercise any of the other means available to them. Another aspect of the SEBI regulations is that in most public issues. inter alia as a part of corporate governance system in India. One of the most valuable is the information on the performance of other companies in the same group. • Broadening the Definition of Independent Director • Compensation to Non Executive Directors and Disclosure thereof • • Periodical Review by Independent Director Code of Conduct • Non–Executive Directors – Not to hold office for more than Nine Years • • • • Audit Committee Review of information by Audit Committee Disclosure of Accounting Treatment Whistle Blower Policy . This may not be an effective safeguard where the dominant shareholders hold a large majority of the shares so that they need to get the approval of only a small chunk of minority shareholders to reach the 75% level. In India. Disclosure does not by itself provide the means to block the dominant shareholders. SEBI has added substantially to these requirements in an attempt to make these documents more meaningful. It also requires that when shareholder approval is sought for various decisions. as part of its endeavor to improve the standards of corporate governance in line with the needs of a dynamic market prescribes the following. Some of these disclosures are important in the context of dealing with the dominant shareholder. the company must provide all material facts relating to these resolutions including the interest of directors and their relatives in the matter. but from one sided deals which help them transfer profits to other entities owned by the promoters themselves.members. Company law provides for regular accounting information to be supplied to the shareholders along with a report by the auditors. Most of their rewards would come not from dividends or from appreciation in share values. Promoters who might have planned to have a very small equity stake could still be dominant shareholders because of large blocks of passive shareholders. However. the promoters (typically the dominant shareholders) are required to take a minimum stake in the capital of the company and to retain these shares for a specific lock in period. particularly those companies which have accessed the capital markets in the recent past. Another safeguard in the Company Law is the requirement that certain major decisions have to be approved by a special majority of 75% or 90% of the shareholders by value. Such promoters would be in the position to exercise effective control while having very little stake in the company itself. This information enables investors to make a judgment about the past conduct of the dominant shareholder and factor that into any future dealings with him. the Securities and Exchange Board of India (SEBI) was set up as a statutory authority in 1992. SEBI.
The Sarbanes-Oxley legislation in the USA. can very well be an important issue in many cases. More needs to be done to ensure adequate corporate governance in the average Indian company. But the question that remains unanswered is whether holders of Foreign Currency Convertible Bonds who are unsecured creditors to an issuing company. More and more it appears that outside agencies like analysts and stock markets (particularly foreign markets for companies making GDR & FCCB issues) have the most influence on the actions of managers in the leading companies of the country. Several committees and groups have looked into this issue that . But their influence is restricted to the few top (albeit largest) companies. Conclusion With the recent spate of corporate scandals and the subsequent interest in corporate governance. The agency problem is likely to be less marked there as ownership and control are generally not separated. Risk management. The problem for private companies. Development of norms and guidelines are an important first step in a serious effort to improve corporate governance. • Company Secretary in Practice to Issue Certificate of Compliance • Additional disclosure Governance in the Report on Corporate • Additional Disclosures under Non-Mandatory Requirements like Audit Qualifications. a plethora of corporate governance norms and standards have sprouted around the globe. But developing countries have not fallen behind either. In the last few years the thinking on the topic in India has gradually crystallized into the development of norms for listed companies. Nevertheless. the Cadbury Committee recommendations for European companies and the OECD principles of corporate governance are perhaps the best known among these. remains largely unaddressed. that form a vast majority of Indian corporate entities. Utilization of proceeds from Initial Public Offerings • • Certification by CEO/CFO Report on Corporate Governance undoubtedly deserves all the attention it can get. The bigger challenge in India. the future of corporate governance in India promises to be distinctly better than the past. India has been no exception to the rule. are secured in matters dealt above. Even the most prudent norms can be hoodwinked in a system plagued with widespread corruption. Training of Board Members and Mechanism for evaluating Non-Executive Board Members.• • Subsidiary Companies Disclosure of contingent liabilities • Additional Disclosures like Basis of related party transactions. with industry organizations and chambers of commerce themselves pushing for an improved corporate governance system. however. Minority shareholder exploitation. however. lies in the proper implementation of those rules at the ground level. Well over a hundred different codes and norms have been identified in recent surveys 28 and their number is steadily increasing.
etc. by ADR Holders filed in the United States of America would be quashed in India. Enforceability of Corporate Governance in India is more or less. any foreign judgment that has been rendered by a superior court within the meaning of that section in any country or territory outside India which the Government of India has by notification in the Official Gazette declared to be in a reciprocating territory for the purposes of Section 44A. But practicably. we should first understand their locus standi. Few of such covenants are discussed as follows: Negative Pledge A negative pledge is a provision which prohibits a party to the contract from creating any security interests over certain property specified in the provision. The Bonds are not rated by any credit rating agency. But Bondholders prior to enforce something similar. . exclusively at the discretion of the shareholders. even though Section 44A of the Civil Procedure Code. Furthermore.Bondholders and Corporate Governance Even though there is no such de jure code of corporate governance for the holders of foreign currency convertible bonds. on the other hand. negative covenants gives more power to the bondholders to preserve their interest in the company. creditors are treated at par on liquidation of a company. may be enforced in India by proceedings in execution as if the judgment had been rendered by the relevant court in India. It should also be noted herein that it is unlikely that a court in India would award damages on the same basis as a foreign court if an action is brought in India. shareholders can sue the existing management of a company for misappropriation of funds apart from oppression and mismanagement. henceforth leaving no scope for further credit appraisal. A party seeking to enforce a foreign judgment in India is required to obtain approval from the RBI to execute such a judgment or to repatriate any amount so recovered outside India. even if such an award is enforceable as a decree of judgment. This gives the bondholders an unique advantage. There are certain positive and negative covenants applicable on the issuer companies which actually protect and preserve the interest of the investors. it is unlikely that an Indian court would enforce foreign judgments if it viewed the amount of damages awarded as excessive or inconsistent with public policy. which safeguards the interests of each other. On the other hand. Since we are concerned with preserving the interests of the Bondholders (actually the Investors). Bondholders are unsecured creditors to a company and not shareholders. Major suits against Satyam. Section 44A of the Civil Code is applicable only to monetary decrees or judgments not being in the nature of any amounts payable in respect of taxes or other charges of a like nature or in respect of a fine or other penalty and shall in no case include an arbitration award. conversion. However. notifying the bondholders and / trustee on any change in the company. However. even though the bonds are embedded with conversion options. the issue of bonds doth has created covenants both on the bondholders and the issuer company. should bear in mind India not being a party to any international treaty in relation to the recognition or enforcement of foreign judgments. repurchase. Positive covenants place affirmative actions to be undertaken by the issuer company like redemption. Creditors and Shareholders being the major claimants to a company.
the trustee of the bonds and the bondholders on any material change in the operations of the company.P. which means senior unsecured debt. but many bondholders may convert their bonds into shares. creates significant leeway for the party that has inserted that condition to avert liability arising out of the issuer company entering into any such transaction that may be prejudicial to the interest of the bondholders Information Rights The key concept behind such covenant is “suppressio veri” or “suppression of truth”. The issuer company is legally obliged to inform such stock exchanges wherein their bonds and shares are listed. such that they acquire a minimum 10% shareholding and subsequently file suits under Section 297 of the Companies Act 1956 against the company. Clauses like “Extraordinary Dividend and Cash Protection” and “Conversion Price Adjustment” are examples of anti dilutive clauses and protects the investor from both percentage and economic dilution.Anti Dilutive Clauses Many actions can have a dilutive effect on outstanding convertible securities. Status of the Bonds The bonds are usually unsecured and unsubordinated. Despite the fact that many countries having higher grades of corporate governance guidelines are prone to mala fide activities of corporate bodies. Event Risk Covenant A provision of the bond which makes the instrument puttable to the issuer following a change of control or a restructuring which reduces the credit quality of the issue. Unsubordinated debt is less risky than subordinated debt. v. which are absolutely detrimental to the interests of the claimants to the company. “the conversion privilege attached to a convertible obligation is subject to dilution and change at the will of the corporation.”. The ratio of the said decision clearly suggests that whenever a corporate entity is . Renusagar Power Co. but protective covenants embedded in foreign currency convertible bonds provides a greater advantage to the bondholders compared to equity holders. This mechanism provides the platform to the bondholders to keep them updated as to the position of the company and guides their future actions in relation to their holding. Conclusion The aforesaid is not akin to the Sarbanes Oxley Act or Clause 49 of the Listing Agreement. Affirmative Approval Clause Requiring the approval of the bondholders. Even though it is not practicable. This is a kind of protective clause allowing the bondholder to demand repayment in the event of a hostile takeover. The principle behind the doctrine of lifting corporate veil and exposing the ruthless domination of selfish promoters is a changing concept and it is expanding its horizon as was held in State of U. Absent contractual protection. In the absence of other senior unsecured debt. But it should also be noted here that unsecured bonds will rank the same in terms of other existing unsecured loans in a company. such bonds will rank in priority amongst the unsecured loan category.
These include the separate entity principle.abused for an unjust and inequitable purpose. they have to make good all the losses or else suffer from penal consequences. the court would not hesitate to lift the veil and look into the realities so as to identify the persons who are guilty and liable therefore. Further. . The following factors are considered by courts to consider piercing the corporate veil. There may be a number of traditional corporate law doctrines which are applied in the European Union to deal with situations wherein the façade of ‘corporation’ is used to commit fraud or illegal acts. Once the veil is lifted by the Indian Courts the liability of the management and shareholders is unlimited. In India as well Supreme Court and the High Courts have used the concept of “lifting of corporate veil” in order to mete out justice to all parties and stakeholders concerned. the limited liability principle. and specific company circumstances) Siphoning of shareholder(s) corporate funds by the dominant • • • Treatment by an individual of the assets of corporation as his/her own. the general conditions for piercing the corporate veil. some courts might find that one factor is so compelling in a particular case that it will find the promoter shareholders personally liable. Was the corporation being used as a "façade" for dominant shareholder(s) personal dealings It is important to note that not all of these factors need to be met in order for the court to pierce the corporate veil. Intermingling of assets of the corporation and of the shareholder Manipulation of assets or liabilities to concentrate the assets or liabilities • • Non-functioning corporate officers and/or directors Significant undercapitalization of the business entity (capitalization requirements vary based on industry. location. • • • • • • • Absence or inaccuracy of corporate records Concealment or misrepresentation of members Failure to maintain arm's length relationships with related entities Failure to observe corporate formalities in terms of behavior and documentation Failure to pay dividends / interests. and the liability of parent corporations for obligations of their subsidiaries. etc.
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